ECA’s latest Cost of living survey took place in a less turbulent context than the previous September survey. However, adjusting international assignee salary packages based upon cost of living differentials did not necessarily become any easier during the course of 2009.
Recent fluctuations in the international currency markets continue to be the primary driver for change when evaluating many of the cost of living index movements that have occurred over the past six or twelve months.
Impact of exchange rates on index movements
The perception of the yen as a safe haven during uncertain times, coupled with the fact that the Japanese economy has been amongst the first to exit recession, has allowed the yen to outperform nearly every other currency. It recently hit a fourteen-year high against the US dollar.
The impact of this on cost of living indices has been quite considerable. In September 2009 a British assignee in Japan would have seen their index increase by 28% in comparison to September 2008. With very little price movements in both countries during that period, it is clear that this index jump is the result of the pound buying less than 80% of the amount of yen it had commanded in September 2008.
While the weakness of the pound has been well documented, this is far from being a unique situation. Assignees to and from various other countries will also require a greater index to be applied to their salary packages and, as Table 1 overleaf highlights, most of the increase in these indices (Column A), if not all, is due to the exchange rate changes (Column B).
Exchange rate fluctuations during the final quarter of 2008 were particularly volatile. So much so that ECA decided to publish a second set of September 2008 cost of living indices, calculated using exchange rates prevailing at the end of November 2008. In a number of cases, these gave a very different outcome – even index decreases – as Columns C and D in Table 1 reveal.
These examples show just how important it is to reference a suitable exchange rate when calculating the cost of living index for an international assignment. Users of the cost of living calculator on ECA’s website have the option to customise the exchange rate to ensure that the index is relevant to the time and circumstances of its application.
Falling indices
Other notable index movements concern assignments into and out of Ukraine. Whereas Japan’s currency has strengthened, the hryvnia has weakened dramatically as a consequence of the global financial crisis. In addition to the contraction of what had, until recently, been a booming property sector in Kiev, the economic downturn has had a negative impact upon worldwide metal prices and the Ukrainian economy’s heavy reliance upon steel exports has seen the country hit harder than most. With prices tumbling, demand for hryvnia has also subsided leaving it considerably weakened against many currencies.
The impact upon cost of living has been no less dramatic. In September 2008, an assignee sent from the United States to Kiev would require an index of more than 100. Despite prices in ECA’s cost of living basket for Kiev increasing by more than 12%, and there being deflation in the home location, the index fell to less than 100 in our latest survey. Within a year, Kiev had gone from being more expensive than the US to cheaper.
This is surprising, perhaps, until we consider that at the time of the September 2008 survey one US dollar bought around 4.7 hryvnia but that 12 months later it bought almost twice that. The impact of price movements in the home and host locations has been rendered largely insignificant due to the fact that every unit of home currency now goes so much further than before.
Even in countries with much higher inflation, we have seen cases of the index decreasing. For example, whilst the standard index for a South African in the Democratic Republic of Congo indicates that the cost of living is more than double that at home, the index has fallen nearly 20% even though prices jumped nearly 30% in the host location. Again, the weakness of the host currency has resulted in a cheaper cost of living in Kinshasa for those on assignment from countries with stronger-performing currencies.
Recent fluctuations in the international currency markets continue to be the primary driver for change when evaluating many of the cost of living index movements
Price movements
On the whole, inflation rates have been less pronounced this survey than when ECA conducted it in September 2008, with many countries experiencing very low or negative inflation. However, the price of petrol remains susceptible to greater variation.
Following the March 2009 survey we reported that petrol prices in many countries had depreciated sharply as crude oil prices fell to a fraction of the record highs seen in 2008. In the succeeding six months, crude oil prices recovered, increasing from around USD 40 to USD 70 per barrel. While still a long way off the USD 100+ highs we witnessed at the time of the September 2008 survey, this trend towards increasing oil prices is reflected in many locations in our most recent survey.
Given that the proportion of expenditure on petrol in the ECA basket can be greater than official government statistics, which include goods and services not purchased on a day to day basis, it is easy to see why ECA’s inflation figures may be lower than government reports.
Index changes
ECA recognises that users of its cost of living data often like to distinguish between how exchange rates, home prices and host prices have each influenced index movements. Information to deconstruct the overall movement in the index can be accessed via the new Index Changes tab on the cost of living calculator (see fig 1). This information is also available in the cost of living reports.
Additionally, ECA now sends out email alerts to subscribers detailing updates to home/host country combinations along with details, where applicable, of indices that have changed the most.
While, exchange rates remain the dominant factor in most cost of living index movements, if the global economy and currency markets continue to stabilise, we may find that price inflation once again takes on greater significance when evaluating index trends for cost of living differentials.
Whatever the future holds, if you need help understanding or applying new cost of living indices or would like to access countries not currently included in your subscription, please don’t hesitate to contact us.